How do I determine the amount of equity that I should provide to an investor in my company?
I have a consulting company which is just incorporated, but yet to commence operations. However, someone has offered to invest $5,000 in my company in exchange for equity. How much equity is that worth?
Congratulations on starting your company!
I think you need to clarify some important questions: Why is this person offering to invest in your company? Are they looking for "passive" investment or more active ownership in the company? Why did he or she choose your start-up in particular?
Valuations are standard protocol for established companies looking to restructure ownership. But start-ups with no track record have no easy way of determining the equity percentage. You may want to consider delaying any equity ownership discussions until your company is more established. In the meantime, personal capital and business debt may be easier ways to grow your company. Here's a link to my recent blog post called "Financing Your Way to Business Growth." I hope it is helpful.
There are a number of ways to value a company. One commonly used for small companies is a multiple of annual revenues. Small companies generally carry multiples in the range of 1-3. My suggestion is to find a CPA that does business valuation and get an estimate. Consulting companies often rely on "good will" for revenues and this can be hard to price. Once you have a rough idea for the company's value, then you know what percentage of equity is worth $5,000. Best of luck!
There is no easy way to answer that question, since you would have to know the value of your company and its likely future value in several years--and you should know that better than anyone else. You can make an estimate by guessing how much profit your company will make in a year like 2020 and then multiply that by a factor like 10 or 20 which should give you a general estimate of its value if it were to be publicly traded. However, it would only be a guess. In general, it doesn't make sense to give someone else part ownership of a company for just five thousand dollars, since you will end up being obligated to that person in one way or another even if you end up with a multi-million dollar product.
I would instead recommend listening to the potential investor's recommendations for growing your company and considering whether they may be useful. You can probably get that information at no charge.
It will certainly be challenging to evaluate an exact value of equity since the company is new and does not have a track record of revenues to determine a business valuation. My advice would be to consult with a CPA or tax attorney.
Wow, it could be 1% or 50%, it depends upon your prospects & expected sales/revenue. Without knowing any of those details I cannot even begin to give you good advice. There are many different way to value a business. Generally though, and at a very simple level, you could base a consulting business on expected revenue. Certain types of ongoing consulting businesses command a valuation of 3x, 4x, 6x, or even 8x revenue. This depends upon the type of business & stability of revenue. Your business, though, would be discounted from that because it isn't a going concern yet and has no revenue. You will need to base it off of your business plan and any contingent contracts you may have.
Sorry I couldn't be more help, Dan Stewart CFA®